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A balancing act between capital and liquidity

Goola Warden
Goola Warden3/16/2023 07:03 PM GMT+08  • 8 min read
A balancing act between capital and liquidity
Fortunately for Singapore, our local banks are required to conduct stress tests regularly and comply with the Basel Committee for Banking Supervision’s (BCBS) liquidity and capital ratios. Photo: Stock image
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The tentacles of the US Reform Law in 2018 did not reach our shores. Fortunately for Singapore, our local banks are required to conduct stress tests regularly and comply with the Basel Committee for Banking Supervision’s (BCBS) liquidity and capital ratios. The local banks are also likely to be largely untouched by Credit Suisse Group's woes as they have stated their exposures are insignificant.

The local banks have just emerged from the pandemic during which they set aside large amounts of general provisions and increased their management overlays. Despite the improving credit environment in 2022, the banks have written back only very modest amounts of the general provisioning or GP. Still, the overlays remain untouched.

“A large part of the general provision management overlay was set aside during Covid. Back then, we communicated that changes to the overlay, including any reversal, will depend on how the situation pans out. Stress tests of our portfolio resulted in an estimated expected credit loss (ECL) figure that was consistent with what we had set aside at that point in time,” said Chng Sok Hui, group CFO of DBS Group Holdings during its results briefing on Feb 13.

“Specific provisions (SPs) were at 8 bps of loans for 2022 and we currently do not expect to see any material pick up in credit costs. The reason why we guided for 10– 15 bps of credit costs is precisely because we do not know the extent of the lagged impact of higher interest rates. We also have a sizable general allowance management overlay which remains untouched. We did not reverse it last year or the year before unlike many other banks. Therefore, even if some unexpected SPs materialise, we have the capacity to absorb it from our existing buffers,” says Piyush Gupta, group CEO at DBS.

Management overlays are amounts kept aside for times of uncertainty, over and above the provisions for ECL required by banks’ macroeconomic variable (MEV) models. DBS has announced that its management overlay is $2 billion while United Overseas Bank (UOB) guided its management overlay is around $1.4 billion to $1.5 billion. Oversea-Chinese Banking Corp’s (OCBC) management declined to reveal its overlay which is believed to be either below or around $1 billion.

Credit risks manageable

See also: Bracing for more aftershocks

“Singapore banks’ risk profiles are resilient as defaults on unsecured retail, home and SME loans look modest in the event of a slowdown. DBS’s mortgage risk profile beats that of peers, and UOB’s unsecured retail loans appear healthy as the lender consolidates Citi’s assets post-acquisition. OCBC’s weaker-than-peers quality in SME loans may warrant scrutiny,” notes Rena Kwok, a credit analyst at Bloomberg Intelligence.

According to Kwok, credit losses in Singapore banks’ loans to SMEs appear manageable despite rising headwinds, because of “improving credit quality nurtured by tight underwriting”. Interestingly, Kwok points out that risks might also be offset by the extension of the enterprise-financing scheme and the energy efficiency grant in the 2023 budget to assist local SMEs with funding and higher energy prices. “UOB may gain the most from the budget, given its larger-than-peers SME loan portfolio,” she says.

DBS’s mortgages are likely to be more resilient than peers in the event of a recession. “As of 4Q22, the average probability of default (PD) of DBS’s mortgages stood at 0.5%, the lowest in its peer group. The lenders have kept their mortgage PDs below 2.5% since 4Q2019, thanks to tight risk controls, low loan-to-value ratios, resilient households and macroprudential steps,” Kwok says. These are likely to keep credit losses limited.

See also: SVB collapse unlikely to cause systemic risk, say analysts

Securities portfolio of banks

All banks have available for sale (AFS) securities as part of a diversified asset base. According to an OCBC Credit Research report, SVB’s balance sheet was highly unique with its assets focused on investment securities, and liabilities skewed to deposits. SVB’s investment portfolio comprised 55% of its total assets as at the end of 2022 while Bloomberg reported that amongst 74 major US banks, none had more than 42%.

“A closer look at home shows a similar ratio at less than 20% for Singapore’s local banks,” OCBC Credit Research says. Indeed, as at end-2022, DBS’s government bonds and T-bills, and bank and corporate securities account for around 19.7% of total assets, while the loan portfolio accounts for 55% of assets. Government securities and T-bills account for 15.5% of OCBC’s assets (excluding Great Eastern Holdings) while loans accounted for 63%. At UOB, Singapore and other government securities accounted for 14.2% of assets, while loans accounted for 62.5%.

Hence Singapore banks have a diversified asset base, including diversified loan portfolios. Furthermore, Singapore banks are diversifying their loan portfolios geographically.

The mark-to-market losses from the local banks’ available for sale securities portfolio are very modest. “Singapore banks with big excess capital reserves over minimum regulatory hurdles can cope with any unexpected credit losses if the financial problems of SVB destabilise markets. Unrealised investment losses [for the local banks] due to higher-for-longer rates look manageable,” notes Kwok.

“SVB’s loan portfolio, albeit smaller than for standard commercial banks that comprise above 50% of total assets, is also highly concentrated as at the end of 2022 with around 56% of its loans to primarily private equity/venture capital clients that are for capital call lines secured by LP capital commitments,” OCBC Credit Research points out.

In addition, 87.5% of its deposits as at end-December were not FDIC insured, with 59.1% in the form of demand deposits which can be withdrawn more easily (versus checking and savings accounts), OCBC Credit Research adds.

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Ample capital and liquidity

In sum, the local banks have ample capital based on their common equity tier 1 ratios, and ample liquidity — based on the liquidity coverage ratios and net stable funding ratios.

“We are a domestic systemically important bank in Singapore with a sizable and diversified deposits base. Our securities portfolio is short duration and highly liquid and repurchase eligible. The above attributes are reflected by our strong liquidity ratios, with liquidity coverage ratio and net stable funding ratio both comfortably above regulatory,” a UOB spokesperson says.

Similarly, a DBS spokesperson says, “We have very strong liquidity and a diversified funding base that is supported by a solid retail customer deposit franchise. As can be seen from our recent financial results, our loan book benefits from rising interest rates; while our debt securities portfolio has a relatively short duration.”

While the local banks’ Casa (Current Account Saving Account) ratios have fallen y-o-y because of customers’ switching to higher-yielding fixed deposits, the banks remain well funded by deposits as evidenced by the y-o-y decline in loan-to-deposit ratios.

Largest NIM and NII growth over

While the local banks are structurally well positioned to ride the turmoil in the global banking sector, the largest gains for their net interest margins and net interest income may well be over for the time being. “Margins will peak, and tepid loan growth will crimp further upside,” says S&P credit analyst Ivan Tan.

NIMs look set to peak this year after consecutive quarters of rising asset yields throughout 2022. Singapore’s Sora and Sibor have been rising in tandem with the Fed’s hikes. Policy rates are also on the uptrend in all of the major overseas markets where Singapore banks operate, except China.

“In our view, the upside on interest margins will likely start tapering and peak in the middle of 2023, in line with the likely cresting in the Fed’s rate cycle,” Tan says. At the same time, funding costs are starting to catch up. “Depositors have been shifting into higher-yielding fixed deposits, and the proportion of low-cost current and savings account deposits has steadily declined over consecutive quarters,” he indicates.

In addition, borrowing appetite will likely moderate this year. S&P Analytics is forecasting loan growth in the low and mid single-digits in 2023. Systemwide gross loans for Singapore commercial banks have declined for three consecutive months since September 2022, the report says. This coincided with a spike in lending yields, which will continue to weigh on consumers and businesses this year.

Other headwinds on credit demand include property-cooling measures in Singapore and recession risk for major economies, the report adds “The realities of higher borrowing costs, coupled with still elevated inflation, will register more prominently in 2023,” says Tan.

Gross NPL ratios for banks could weaken slightly over the next 12– 18 months. The banks also have exposure to economies in Indonesia and Thailand, where the level of restructured loans remains elevated post-Covid, the S&P report says.

With the highest growth over, and risks emerging, Maybank is downgrading the banks. While it has a top preference for DBS, it has downgraded UOB and OCBC to neutral.

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